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Livestock Insurance Program Could Aid Struggling Dairy Producers

March 30, 2009

COLUMBUS, Ohio -- A new livestock insurance program that pays out when milk income, minus the feed expenses, declines below a set level, could mean the difference between business survival or bankruptcy for struggling dairy producers.

The Livestock Gross Margin Dairy Insurance product, originally developed by the Federal Crop Insurance Corporation for feeder cattle and hog producers, is now available for dairy producers. The program, similar to crop insurance programs, pays producers when actual gross margin is less than anticipated gross margin at the end of the insurance contract period. Gross margin is calculated as the difference between expected gross revenue and expected purchased feed cost and is based on market prices for milk and grain commodities.

"With this insurance program, farmers can pay a premium and if their income remaining after their feed costs is below a certain level, they receive an indemnity check," said Cameron Thraen, an Ohio State University Extension dairy economist. "If farmers can't weather an income drop below a certain dollar value per hundredweight without going out of business, this insurance policy exists to prevent that from possibly happening."

With the current state of the nation's dairy industry looking bleak with falling milk demand globally and continuing high feed costs, Thraen said that the Livestock Gross Margin Dairy Insurance might be an option to help vulnerable producers stay afloat.

"With the recession and current economic downturn, milk prices and feed costs for the first six months are low but milk prices are currently much higher for the last six months of 2009. This suggests that there could be a real opportunity to lock in pretty good gross margin insurance coverage for the last part of the year," said Thraen, who also holds an appointment with the Ohio Agricultural Research and Development Center. "For some farmers, when you calculate all of the other costs like feed, fuel, vet bills, utilities and labor, their costs to produce milk exceeds their cash income from milk sales. Many dairy producers will be forced out this year because they can no longer withstand the negative returns."

The economic situation is particularly troubling for Ohio dairy producers because milk revenue isn't enough to meet production costs given the smaller scale of production and higher feed costs driven by the corn-ethanol cycle, said Thraen.

"Ninety four percent of the dairy herds in Ohio are 199 cows or fewer. Ohio's average annual milk production per cow is 18,321 pounds per cow. That's significantly lower than the national average of 20,396 pounds per cow," said Thraen. "Using USDA cost and returns data, which reflect an average or typical Ohio dairy producer, economic losses are in the neighborhood of $17 to $20 per hundredweight. There simply isn't enough revenue being generated from the sale of milk right now to stay profitable at the smaller herd size. The production per cow is not high enough."

In such situations, the Livestock Gross Margin Dairy Insurance may be a benefit, said Thraen.

"These producers are not in a good position to self insure. Self insuring means your dairy generates enough profit in the good times such that you can weather the bad times without a financial emergency or bankruptcy. Also, dairy farmers can provide market price insurance themselves by using futures and option markets, but it's more complicated to come up with the right combination of milk and grain options," said Thraen. "This insurance product does it for them. It's much simpler to use once they understand the product."

There are downsides, however, to the Livestock Gross Margin Dairy Insurance that Thraen hopes will be readjusted as time goes on.

One is the very narrow time window when the product can be purchased from a crop insurance agent. Another is that the entire premium payment is due at the time the contract is purchased. Premiums can run into the multiple thousands of dollars, making it a daunting task to come up with the money up front.

"There are some discussions taking place that would make the insurance more affordable, like making half of the premium payment at the time of purchase and paying the other half at a later date," said Thraen.

Another downside is that the insurance doesn't pay out until the policy expires.

"If a producer takes out the policy for 10 months, a payment might be generated two months into the program, but a producer won't see the money until the policy is up eight months later," said Thraen. "That doesn't help the producer who might need the money right away."

Because the product is so new, being available only since August 2008, it is unclear whether or not the banker will take due, but yet to be paid, insurance indemnities as loan collateral, Thraen said.

In addition, unlike crop insurance programs, no premium subsidies exist under the Livestock Gross Margin Insurance program. Thraen said that such subsidies would help make the insurance more attractive and more affordable to those who really have no other opportunities.

"It's a good product and with some important modifications it can be a useful tool for dairy farmers to consider. From an insurance standpoint, it makes sense to move from crops to the livestock side of things, but there need to be better approaches to its affordability if farmers are to take it seriously," said Thraen.